This is the age of government regulation. Businesses pay millions of dollars each year to comply with ever-increasing regulatory requirements intended to avoid catastrophic loss to persons and property. While corporate America underwrites the lion’s share of the cost associated with enhanced safety, the benefits are realized primarily by consumers, politicians and insurers. Yes, insurers. A dollar spent on preventing loss is a dollar saved by insurance companies.
Historically, the economic realities of this inverse moral hazard were addressed in ocean marine insurance policies by the “sue and labor” clause. If, for example, a ship owner repaired a breach in a vessel’s hull thereby preventing the loss of the ship and cargo, the cost of repairing the hull would be reimbursed under a “sue and labor” clause. While the earliest “sue and labor” provisions date back as early as the seventeenth century, most modern commercial property policies have a “sue and labor” equivalent—compelling the insured, in the case of actual or imminent loss or damage, to “sue, labor and travel for, in and about the defense, safeguard and recovery of the property insured,” with the insurer and insured liable for the costs according to their interest.
Can the “sue and labor” clause found in today’s commercial property policies offset the cost to policyholders of meeting government regulations designed to prevent loss of insured property? A case in point: in May, the Department of Transportation (“DOT”) announced a final rule “to strengthen safe transportation of flammable liquids by rail.” The rule creates (1) new tank car requirements (along with a retrofitting schedule for older tank cars); and (2) new braking standards. By its terms, the regulation was issued in response to train accidents involving substantial property damage and personal injury. According to the DOT, the rule is expressly intended to reduce the likelihood of train accidents and mitigate the consequences of such accidents.1 Early estimates suggest that compliance with the braking standards alone will cost up to $10,000 per rail car.2
The expenses to be paid by tank car owners and rail carriers to satisfy these enhanced standards meet the letter of the traditional “sue and labor” clause. Such expenses are incurred, not to avoid liability, but to preserve insured property and mitigate loss and damage. The mandate from regulators is in response to actual damage to property and what has been characterized as an “imminent hazard to the safe transportation of hazardous materials.”3 And in the event of a future accident, the safeguards purchased through compliance will undoubtedly reduce insured property damage and business interruption.
Other examples of costly regulatory mandates abound. As recently as last week, the U.S. Food and Drug Administration urged companies to begin now to prepare for new regulations to be issued pursuant to the Food Safety Modernization Act.4 Compliance with these regulations—aimed at improving sanitary transportation of human and animal food—will be expensive and, like the recent rail-safety rule, will prevent insured damage to inventories and loss of business income.
At the turn of this century, some policyholders attempted to test the boundaries of the “sue and labor” clause in another context—Y2K preparedness. A series of high-profile lawsuits were filed seeking to recover the tens of millions of dollars spent to avoid the catastrophes feared when the calendar turned to a new millennium. Among the hundreds of claims made, some were denied on technical grounds. Many were rejected on grounds that the damage prevented was excluded as caused by an “inherent vice.”5 Other claims settled. But, unlike the Y2K claims of 1999, much of today’s compliance costs are not incurred to correct an uninsured defect in design or construction. No insurer could credibly argue, for example, that first-party loss and damage to insured property from a rail car disaster involving the transportation of flammable liquids is excluded or uninsured.
While each policy and each claim is unique, “sue and labor” coverage may in fact provide a means for corporate policyholders to recover costs incurred to comply with regulations that prevent otherwise insured property damage and business interruption. “The purpose of the sue and labor clause is to reimburse the insured for those expenditures which are made primarily for the benefit of the insurer to reduce or eliminate a covered loss.”6 Corporate policyholders should not forego the opportunity to recover regulatory compliance costs that serve this purpose.